Did you know that some loans and credit cards represent two different types of credit? A mortgage loan or personal loan, for example, are typically considered installment credit. Most credit cards, on the other hand, are regarded as revolving credit.
To learn more, here are the definitions and a comparison for both types credit.
Installment credit basics
With installment credit, you borrow a specific amount of money and have a set amount of time to repay the loan. The loan can have a fixed rate, which won’t change over the term of your loan, or a variable rate, which may rise or fall during the loan term. Mortgages, auto loans, student loans and personal loans are all examples of installment credit.
Installment loans can either be secured or unsecured. Secured loans are backed by something of value, like a home or car, which the lender can take if you do not pay the loan back in full. Unsecured loans don’t require you to put any property at risk, but interest rates are often higher since the lender faces more potential risk.
Understanding revolving credit
Revolving credit is open-ended and is not required to be paid off within any specified number of months or years. Each lender gives you a credit limit, which is the maximum amount of debt that can be outstanding with that particular lender. The amount you’ll pay each month may change, depending on how much of your available credit you use. As you use the credit, the amount of money available to you decreases. As you repay it, it goes back up. Credit cards and lines of credit are both examples of revolving credit.
Comparing installment credit and revolving credit
A typical use of installment credit could be to pay for big ticket items like a home, vehicle or college education. Revolving credit, however, is commonly used for everyday purchases like food, gas and clothes.
The benefits of installment credit can include:
- Lower interest rates
- If the rate is fixed, the payment amount is the same each month
- Interest is only charged on the original amount borrowed
The advantages of revolving credit can include:
- Flexibility to change your monthly payments
- The ability to access your credit as often as you’d like as long as you don’t go over your credit limit
- No application or waiting time to get money once the card or line of credit is open
Keep in mind that some credit cards charge annual fees, late payment fees and fees for going over your credit limit. Also, since there’s no set time for paying off revolving credit, your overall debt could increase as more interest accrues on your outstanding balance.
Research before you choose
When deciding on what kind of credit to obtain, look at the advantages and disadvantages for all types and pick the one that matches your particular needs.